The Baltic Dry Index remains strong in an uptrend while commodities crash in a downtrend. Something has to give. Stocks crash while bond yields drop seems to be normal, however with the fed pushing prices higher, perhaps this relationship continuing isn’t as warranted as it used to be. What makes sense for treasuries is that if the fed guarantees purchase that will likely push yields lower, they will have someone else to sell so buyers flood in. However if large central banks around the world seek to get long the dollar since it is the reserve currency, they also should buy gold as a hedge. This has happened but recently gold has dropped as dollar becomes stronger. This could be merely some re-balancing as the dollar increases in value, less gold is needed as a hedge to maintain the same dollar/gold ratio. when valued in another currency. Volatility remains high. Earnings estimates are high and earnings are high, but no one seems to believe the estimates, or else is worried that the multiples will be lower due to macro risk. Macro risk is high, but how much higher will fears get? Greece may default, or there may be some other miracle such as this one. Liquidity may be a concern, but how much cheaper will we see multiples trade when there is so much government intervention any time the market sneezes.
But no relationship is fixed. Historically there were times when gold would rally every time the market declined, but looking back in a very long term view, gold tends to go up during times of monetary expansion along with everything else. Gold higher=stocks higher. I am skeptical of bond demand higher (yields lower)=stocks lower as I don’t think this is a relationship that is set in stone. I certainly understand why traders would react as if that relationship will maintain that way, but at some point that will likely change.
What the market is telling me is that the US government is twice as likely to pay back their promise than Johnson and Johnson over 10 years as the yields of JNJ are TWICE as high. Well, I suppose the government could potentially increase taxes on every solvent business to try to pay it’s obligations, however I have seen numbers that suggest that the government has no way to pay it’s obligations and historically they never do, they just push it off down the road and eventually restructure the debt in some way or come up with some sleight of hand action. Potentially they could create another agency that could print money at will or have some kind of “super fed” that regulates multiple other feds and the “superfed” would become to the other federal reserves what banks are to the federal reserve. The federal reserve is leveraged something like 50 to 1 and if not for their ability to print money at will they would be as insolvent as Lehman, and Lehman was only leveraged 35:1 before they went belly up.
You can bet several ways. You can bet against stock indices and on basic materials as well as basic material stocks. This way if you expect either the baltic dry index to be too high or commodities too low, but aren’t sure if the baltic dry index is temporarily too high and we are headed to reccession or if the stocks, particularly the goods that are shipped such as basic materials are too low and that there are irrational fears of reccession…. With this pair trade, you would expect the two to converge and regress towards a more “regular” correlation.
Another bet is that either 10-year treasuries yields are too low, or stocks are too high, and perhaps both. You would bet against treasuries (bet on higher yields) and lower stocks. Personally, I would want to bet ON stocks, and against treasuries over the next 5 years, although in the short term things could get dicey in the market.
Another relationship is the VIX being only half way to 2008 extremes, while treasuries (TLT) is in fact at 2008 extremes. The hedge play would to be to bet against treasuries (short TLT or long TBT) and against volatility (short VXX, or an inverse VXX etf like XIV).
Finally, gold is crashing. Either this is a sign of liquidity dry up which would explain why commodities and basic materials are going lower but would not explain the baltic dry index… Or perhaps it’s a sign that with the dollar temporarily gaining strength that not as much gold is needed to hedge treasuries for the time being. Or it could be that there is a wealth transfer out of gold and that the “security” of treasuries is a trade on it’s last legs and selling gold is occurring because there is potentially a move to dump treasuries to the fed, or the fed’s announcement for “operation twist” has postponed that move. I am not sure how to play this, I am potentially considering long basic materials short gold as a hedge and short stocks. Volatility is also something to look to bet against, although I would wait until the end of October.
Noticing past relationships that you believe still make sense but are currently doing the opposite (a “divergence”) often can be observed and a pair trade corresponding to playing on things going “back to normal” can be made. This is similar to an arbitrage, you are just noticing things that don’t make sense and not really picking sides, but playing both sides. This is also known as “hedging” and can sometimes be used to protect yourself.
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